Regulators around the world watching Canada’s markets for guidance: TABB Group

TABB Group: Global regulators watching Canada's markets for guidance

Canada was just dipping a toe into dark trading — a method of buying and selling large blocks of securities where the transactions are less likely to tip off other market players — when regulators imposed a new set of rules late last year aimed at protecting small traders.

But the effect was dramatic and has drawn the attention of regulators around the world, including some in jurisdictions that have allowed technology-enabled trends like dark pools to become much more fully entrenched, according to a new report from TABB Group, a respected Massachusetts-based financial markets research and advisory firm.

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“Regulators worldwide are watching the equity markets in Canada, where changes are being steadily implemented in a bid to find the optimal balance between protecting the markets and allowing for sufficient growth,” declared the TABB Group report published Monday.

Author Miranda Mizen noted that Canadian regulators were at the forefront not only of creating a set of strong rules to govern dark trading, but also of gathering data to track the effects of a growing business of lightning-fast electronic transactions known as high-frequency trading.

“Fragmentation, dark trading and high-frequency trading are all issues on every regulator’s mind, catapulting Canada into the spotlight as participants, academics, vendors and regulators in other markets watch and wait for the data to determine their own course of action,” says the TABB report.

“This puts Canada in the uncomfortable position of leadership, but also one of envy for its manageable size and regulator agility.”

Dark pools allow traders to enter orders outside traditional “lit” markets, and without what is known as pre-trade transparency. This is viewed as an attractive strategy for institutional investors because large trades are less likely to trigger swings in the price of securities that can reduce the profit from the trade.

When the new dark trading rules crafted by the Canadian Securities Administrators and the Investment Industry Regulatory Organization of Canada (IIROC) were implemented in October, visible orders in a marketplace were given priority over dark orders at the same price.

The rules also demanded “meaningful price improvement” for smaller orders, to balance the interests of small and large traders.

The TABB Group says Canadian banks clearly felt the impact of the new rules.

“Short-term dark liquidity dried up and pushed retail flow to the expensive side of the lit markets,” according to the report. This had the effect of “squeezing the margins of this business for the big Canadian banks.”

The hit has been “doubly hard” for those with a stake in the market but without one in TMX Group, the owner of Canada’s major securities exchanges including the Toronto Stock Exchange.

The TABB Group noted some unique features of the Canadian markets including concentration, which was highlighted last year by the TMX’s purchase of rival trading venue Alpha Group. TMX itself was bought by a consortium of Canadian financial institutions including banks and pensions.

More than 80% of share volume is now traded on a platform owned by TMX Group, the report said.

Only 3% of trades are in dark pools, a figure dwarfed by markets in other jurisdictions such as the United States, “and six Canadian banks command the bulk of the flow,” according to the TABB Group report.

The U.S. financial market research firm also said that while there are seven competing trading venues in Canada, only one, Chi-X, “has made significant inroads with 11% of total volume, and the economics of broker dark pools are poor.”

TABB says the size of Canada’s equity market, ranked eighth in the world in terms of market capitalization, “creates an environment in which the regulators can perhaps be more nimble but there is equally less room to manoeuvre.”